International trade requires a precise understanding of terminology that dictates financial and logistical responsibilities. Global shipping agreements determine when a seller’s obligation ends and a buyer’s begins, directly impacting the final cost of goods. Free On Board (FOB) is a frequently used term that clearly assigns responsibility for costs and the goods themselves during transit. Understanding the exact point of transfer specified by an FOB agreement is fundamental for calculating import and export costs.
Defining Free On Board (FOB) and Incoterms
Free On Board (FOB) is a trade term specifying the obligations of the buyer and seller regarding the transport of goods. FOB is one of the eleven International Commercial Terms (Incoterms), published by the International Chamber of Commerce (ICC) to standardize global trade rules. These rules provide a universally understood set of three-letter codes that define responsibilities for cost, risk, and delivery between trading partners.
The Incoterms 2020 version restricts the use of FOB to shipments involving only sea or inland waterway transport. Under the Incoterms FOB rule, the seller must deliver the goods by placing them on board the vessel nominated by the buyer at the specified port of shipment. The seller covers all costs and risks until the goods are successfully loaded onto the ship. At that point, the financial and physical responsibility transfers entirely to the buyer.
The Fundamental Difference Between FOB Shipping Point and Destination
While the Incoterms FOB rule applies strictly to international sea freight, FOB Shipping Point and FOB Destination are widely used in North American domestic trade. They often appear in international contracts as a simplified way to denote responsibility for land transport. The distinction is based entirely on the point where responsibility for the goods transfers from the seller to the buyer, determining who pays freight charges and assumes the risk of loss or damage during transit.
Under an FOB Shipping Point (or FOB Origin) agreement, responsibility transfers the moment the goods are made available to the carrier at the seller’s location. The seller pays costs only until the goods are loaded onto the carrier. The buyer immediately assumes all subsequent transportation costs, insurance, and liability, taking legal possession at the origin point.
Conversely, an FOB Destination agreement places a greater burden on the seller. Responsibility does not occur until the goods physically arrive at the buyer’s specified location. The seller must absorb all transportation costs and risks, including the main carriage, until delivery is completed at the buyer’s dock. The buyer then assumes responsibility for final costs like unloading.
Specific Charges Associated with FOB Agreements
FOB charges are the itemized costs related to moving the goods from the seller’s premises to the buyer’s final location. The specific FOB term determines who pays for each cost. These costs are broadly categorized based on the stage of the journey, with the FOB point acting as the division line for financial liability.
Pre-Carriage and Origin Charges
The seller is responsible for the costs associated with moving the goods from their facility to the port of shipment, known as pre-carriage or inland freight. This category includes packaging, warehousing, domestic trucking fees, and all documentation required for the export customs clearance process in the country of origin. The seller also pays for the Origin Terminal Handling Charges (OTHC), which are the fees charged by the port operator for preparing the cargo and loading it onto the vessel.
Main Carriage and Ocean Freight
The cost of the main carriage, the primary ocean freight charge for the vessel crossing, is assigned based on the FOB term. Under the Incoterms FOB rule (and the spirit of FOB Shipping Point), the buyer is responsible for contracting and paying the main ocean freight from the named port of shipment to the destination port. If the contract is FOB Destination, the seller must arrange and pay for the main carriage, often incorporating this expense into the final sales price of the goods.
Destination and Import Charges
Upon arrival at the destination port, a new set of charges arises, primarily paid by the buyer regardless of the FOB term used. These Destination Charges include unloading fees, Destination Terminal Handling Charges (DTHC), and costs related to import customs clearance. The buyer is responsible for all import duties, taxes, and tariffs levied by the receiving country. They also cover the final inland transportation from the arrival port to their delivery location.
Understanding the Transfer of Risk and Liability
A distinction exists between the transfer of cost (who pays the freight bill) and the transfer of risk (who is legally liable for the goods). The primary function of an FOB term is to pinpoint the exact moment the goods are legally delivered, which is the instant liability for loss, damage, or theft shifts from the seller to the buyer. This point of transfer holds implications for insurance claims and legal recourse.
In an FOB Shipping Point arrangement, the buyer assumes all risk the moment the goods are loaded onto the first carrier at the origin point. If the cargo is damaged during transit, the buyer must file the claim with the insurance provider. Conversely, with an FOB Destination agreement, the seller retains full liability for the entire journey until the goods are safely delivered to the buyer’s specified location. If the shipment is lost or destroyed en route, the seller must bear the financial loss or pursue the claim.
How FOB Differs from Other Incoterms
FOB occupies a middle ground in the spectrum of Incoterms, which range from those placing maximum burden on the buyer to those placing maximum burden on the seller. Comparing FOB to other common terms clarifies why it is frequently chosen as a balanced agreement.
The term Ex Works (EXW) represents the minimum obligation for the seller. The transfer of risk and cost occurs the moment the goods are made available at the seller’s premises. Under EXW, the buyer is responsible for all subsequent logistics, including loading the goods, arranging export clearance, and paying every transportation charge to the final destination. FOB places more responsibility on the seller than EXW, requiring them to handle the inland transport and the loading process onto the vessel.
Cost, Insurance, and Freight (CIF) places a significantly larger cost burden on the seller than FOB. Under CIF, the seller is required to arrange and pay for the main carriage and minimum insurance coverage to the destination port. The difference from FOB is that while the seller pays the freight under CIF, the risk of loss transfers the moment the goods are loaded onto the vessel at the port of origin, similar to FOB. This means the buyer must still file any insurance claims for damage that occurs during the main voyage, even though the seller paid the freight charge.